Thursday, 11 December 2014

Getting more from Monetary Policy

Japan has made lots
of mistakes and it is time that Europe learnt from them

We can all learn from watching others make mistakes and the
experiences of Japan continue to provide valuable lessons. Japan has stumbled into another recession
following a hike in taxes to fix the government’s finances. The other key policy doing the rounds in
Japan, using expansive monetary policy to put an end to deflation, also seems
to be flagging. It is Europe that has
most to learn from the unfortunate trials and tribulations in Japan since many
of the same problems are shared by both.
What should Europe do to avoid making the same mistakes and decades of
stagnation?

Following in the same
footsteps

Japan has been hit first with many of the same problems that
are increasingly expected to plague Europe and other Western countries. For starters, new-borns in Japan are increasingly
outnumbered by pensioners which have pushed the population into decline in
recent years with an aversion to immigration further accentuating this trend. This translates to fewer workers to provide
the taxes needed for the rising costs involved with taking care of old people. The situation is made worse by government
debt which is already more than double GDP due to years of inefficient government spending.

Japanese consumer prices have been falling for years as a
reflection of the weak demand. There are
few opportunities to profit from in Japan due to the falling population and
even Japanese firms are looking elsewhere to invest. Weak global demand means that even one of
Japan’s strengths, exporting, offers only limited respite even with a weaker yen due to its loose
monetary policy. All of this
means that the Japanese economy itself is like a tottery pensioner - even a
small rise of sales tax from 5% to 8% was enough to push Japan back into
recession. This does not bode well for
Europe where the economy is sputtering along due to many of the same problems
while the governments there are also trying to get a grip on their finances.

Trying different
directions

Having been stuck with these problems for longer, policy
makers in Japan are increasingly more aggressive in coming up with
solutions. The current prime minister,
Shinzo Abe, launched a raft of new measures dominated by a massive expansion of
the money supply to target falling prices.
This new aggressive approach to monetary policy was facilitated by the
government installing a new governor to the Bank of Japan who was willing to
give up its independence and toe the line.

This is the complete opposite to the situation in
Europe. The head of the European Central
Bank is eager to do more with monetary policy but is prevented from doing so by
the German government. German politicians
want to reforms to come first due to an expectation that their neighbours will not
implement the necessary policies. Whereas, in Japan, the aim was to use the
loose monetary policy to help build momentum that will allow the government to
implement reforms.

Yet, the Abe government has been disappointing in its reform
efforts (as Your Neighbourhood Economist predicted) and this will bolster the stance
taken by Germany. With the Bank of Japan
finding it tough to generate sufficient inflation despite a rapidly expanding money
supply through quantitative easing, many will question about the reasons behind
using a similar policy in Europe. Central banks are struggling to have much influence in a world that is already awash with surplus cash.

This takes more political willpower when the many countries
of Europe are involved but is not something beyond the realms of
possibility. Ironically, the chances for such a deal may be improving as deflation becomes more of a concerns and the economic
stagnation in Europe also spreads to Germany.
Japan has already paid the price for years of economic mismanagement –
there is no reason for Europe to do the same.